May 2023 Market Lookback

After hiking by 25bps again, the Federal Reserve laid the groundwork for a pause to their rate hiking cycle in coming months. While coming in weaker than expected to start the month, economic data showed resilience as May went along. Treasury yields drifted higher after initially falling during the first week, reaching levels not seen since before the mid-March volatility. Buoyed by the promise of artificial intelligence, large-cap growth companies and other AI-related stocks outperformed while more cyclical names struggled. An agreement was reached late in the month to raise the debt ceiling and is set to be signed into law next week, barring any 11th hour issues.

Macro

•   The Federal Reserve raised the fed funds rate by 25bps on May 3 to a target range of 5%-5.25%.

•   253k jobs were added in April, while February & March saw net revisions of -149k.

•   Existing & new home sales continued to diverge in April — existing sales fell 3.4% while new sales increased by 4.1%.

•   Q1 GDP growth was revised up to 1.3%, while Gross Domestic Income came in at -2.3%.

•   Job openings fell to 9.75m in March before rising to 10.10m in April.

•   A tentative deal on raising the debt ceiling & deficit reduction was reached by Congressional negotiators & the White House.

Equities

•   Bottom-up EPS estimates for the S&P 500 in 2023 inched up to $221 from $220 in May, while top-down strategist estimates stayed at $215.

•   With nearly all S&P 500 companies having reported by the end of May, the earnings surprise rate was 6.9% vs. the prior four-quarter average of 4.2% & post-1994 average of 4.1%.

•   Buoyed by AI excitement, large-cap growth stocks outperformed their value counterparts by 8.4 percentage points — the most since June 2000.

•   The S&P 500’s high-low trading range was 4.4% in May, an uptick from the prior month but still only half of the prior year’s average.

Fixed Income

•   After falling as low as 3.30% May 4, 10Y Treasury yields rose to 3.86% on May 26 before finishing the month at 3.63%.

•   Tracking the broader move in the 10Y, the near-term forward spread inversion deepened to -218bps on May 4, resteepened to -112bps on May 26 before finishing the month at -164bps.

•   While HY bond spreads ended the month just 1bp above where they began, the lowest-rated IG bonds (i.e., BBB-rated) saw spreads widen from 181bps to 187bps.

Crypto

•   Driven in part by the move in Treasury yields, Bitcoin & Ethereum had their first negative return month since December.

Looking Beyond the Debt Ceiling

Investors spent much of May focused on Washington debt ceiling negotiations, but after notable hand-wringing it appears both sides finally reached an agreement on raising the debt ceiling and modifying spending in the form of the Fiscal Responsibility Act. Market participants had been getting increasingly antsy as the early June deadline approached, so, assuming that no last-minute issues prevent the bill from passing, this could serve as a short-term boost for stocks.

However, there will almost certainly be a fiscal drag associated with signing the bill into law. While it’s tough to precisely quantify the exact impact on economic growth, estimates from the CBO & others indicate an overall drag on growth of 0.1%-0.2% through the remainder of 2023 and a 0.5%-0.7% drag in 2024. Deficit reduction is projected to intensify as years go on, which would also increase the effective drag on GDP.

Aside from the direct fiscal impact, raising the debt ceiling will enable the Treasury General Account (TGA) to be refilled through debt issuance. Because some of this issuance will end up sitting at the TGA and not get spent, it could effectively be a removal of liquidity from the market. Given that measures of liquidity and the S&P 500 have followed each other in recent years, and that the economy is set to face fiscal headwinds, a debt ceiling resolution might not be the all-clear some are hoping for.

Artificial Intelligence: The New Thing

Given the belief in the potential for artificial intelligence to transform various industries, companies seen as having favorable exposure to AI have outperformed for much of the year, with that story continuing into May. Having seemingly shrugged off economic concerns & the debt ceiling, AI stocks popped even higher in the aftermath of NVIDIA’s revenue guidance that was ~54% above consensus analyst estimates.

For many investors, this likely served as a sign that the economic impact of AI was no longer in the future, but here today. Large-cap growth stocks closed the month up 4.6%, while the FANG+ index & a basket of AI stocks finished up 16.9% & 35.1%, respectively, while large-cap value stocks & the S&P 500 ended the month down 3.9% & up 0.4%, respectively.

That gap between FANG+ stocks and the S&P 500 was the largest since the index’s inception in September 2014, while the spread between large-cap growth and value stocks was the widest since June 2000, a period in which investors were also excited about a new technology’s potential to reshape the economy (i.e., the Internet) but then eventually saw significant drawdowns. While history doesn’t repeat, it often rhymes — the parallels between the two periods of time are unnerving and something to watch carefully.

Performance data quoted represents past performance. Past performance does not guarantee future results. Market returns will fluctuate, and current performance may be lower or higher than the standardized performance data quoted.